Republican victories abound (check), Fed pushes massive amounts of money into the financial system (check) and the employment report was better than expected (double-check!) and the equity markets continued to rally (check-mate!). The markets got everything they wanted last week and tacked on another 3% as investors figured out that the Fed is likely to backstop anything going bad from here on out – so with risk off the table, let’s buy stocks! While the employment report provided much to cheer about, the huge rally on Thursday and the Fed announcement on Wednesday effectively neutered Friday’s job number. The Fed announcement has rendered much of the November economic data moot, as the new rounds of easing will not work their way into the economic system until sometime early in ’11. The goal of the easing program is to inflate assets so investors feel wealthy enough to begin spending again and building a head of steam for the economy. Whether that works or not is subject to many heated debates and we’ll likely get the answer by mid-’11. For now, assets of all stripes from commodities to bonds to foreign stocks are all rising, courtesy of the Federal Reserve largess. When the music stops, there won’t be too many chairs left!
Since the meeting in Jackson Hole, WY at the end of August when Ben Bernanke told the world they would do whatever it takes to get the US economy humming, the financial markets have jumped in response. The SP500 is up over 15% and foreign markets are also up double digits. However, when you measure in terms of the dollar or gold, those gains don’t look as good. The dollar is down over 9% and gold is up over 11%. Foreign markets, in local currency, are up nicely, but not the huge gains we experienced via the cheaper dollar. While we are essentially cutting intermediate and long-term rates to nothing, Australia is actually increasing their rates. So while investor sentiment is bullish, it is being supported by the very easy money policy of the Fed. Designed to push asset prices higher (everything from equities to gold to bonds) in an effort to create wealth to make people spend some of the wealth to get the economy going. After being up in nine of the past ten weeks, the markets are in need of a rest, however given the desire to hop aboard the money express, it is likely that whatever decline comes from stocks, it will be relatively small compared to the gains enjoyed so far.
Long-term interest rates rose as fears of inflation began to work its way into the bond markets. Shorter rates fell, as the focus of the Fed purchases would be in the 10 years and under category. As a result, spreads between the short and long-term rates were at their widest since mid-June. A stronger economic backdrop would mean the yield spreads should be declining, not widening. During the expansion from ’92 to ’00, the spreads between long and short-term bonds declined from over 5 percentage points to inverted in 2000 as the economy was entering a recession. The same is true during the ’04 to ;06 period, when rate spread fell from over 4% to flat, again just prior to the onset of recession. Given the wide spreads over the past year and a half, the bond market is not so sure that economic recovery is just around the corner.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
